Fannie-Freddie Overseer Easing Loan Buybacks: Mortgages

Banks "have history in the rear-view mirror, and they don't want to ever repeat that," David Stevens, president of the Mortgage Bankers Association, said in an interview. Photographer: Andrew Harrer/Bloomberg

May 13 (Bloomberg) -- Melvin L. Watt, the overseer of
Fannie Mae and Freddie Mac, is loosening rules that have forced
banks to buy back billions of dollars worth of flawed home loans
in an effort to spur the housing market.

Watt, who took over in January as head of the Federal
Housing Finance Agency, will announce in a speech today a series
of steps intended to stimulate lending. More than six years
after the housing bubble burst, lenders remain cautious about
making home loans to borrowers with less-than-perfect credit
because they could end up absorbing losses if the loans default.

The banks’ reticence has kept first-time homebuyers and
others with weak credit out of the real-estate market and
created a drag on the fragile housing recovery. Fannie Mae and
Freddie Mac have forced banks to repurchase defaulted home loans
with a balance of $81.2 billion between 2011 and 2013 alone.
Lenders say that is a major reason they’re still requiring
credit scores averaging about 740 on loans they sell to the
government-owned mortgage companies, far above the sub-700
average before 2007.

Banks “have history in the rear-view mirror, and they
don’t want to ever repeat that,” David Stevens, president of
the Mortgage Bankers Association, said in an interview.

With Fannie Mae and Freddie Mac now guaranteeing two-thirds
of U.S. mortgages, their actions have a broad influence on
lending. Banks say the companies’ campaigns to make them
repurchase $81.2 billion in home loans between 2011 and 2013
alone is a major reason they’re still requiring credit scores
averaging about 740 on loans they sell to Fannie Mae and Freddie
Mac, far above the sub-700 average before 2007.

First Step

The new rules that Watt will announce today in Washington
are a first step in a long-term effort to clarify loan-buyback
policies and ease lender concerns. Banks will be freed of
liability for mortgages with three years of steady payments even
if borrowers send their checks late twice during that time.
They’ll also be off the hook for loans that pass underwriting
spot-checks before the three years are up. Fannie Mae and
Freddie Mac will begin notifying lenders in writing when they’re
relieved of responsibility for each loan.

Details of Watt’s speech were provided to Bloomberg News by
the FHFA.

Fannie Mae and Freddie Mac also will stop automatically
issuing repurchase requests when private mortgage insurers
rescind coverage on loans. Such insurance is required when
borrowers make a down payment of less than 20 percent.

The changes “are important steps towards balancing safe
and sound lending with improving access to credit,” Watt said
in an e-mailed statement. “These changes should provide the
lending community with additional clarity and confidence in
making their lending decisions.”

Watt’s Debut

In his speech, Watt is expected to outline a broad series
of new policies governing the two mortgage-finance companies. It
will be the first public appearance for Watt, a former
Democratic congressman, since he took the lead at FHFA.

In addressing the issue of loan buybacks, also called
putbacks, Watt is answering concerns raised by Federal Reserve
Chair Janet Yellen, who told Congress on May 8 that the
“flattening” housing market “will bear watching.”

New home sales dropped 14.5 percent to a 384,000 annualized
pace in April, the weakest since July, according to Commerce
Department data. The slump was concentrated in homes priced less
than $300,000, showing that entry-level borrowers are being kept
out of the market as prices and interest rates rise, and credit
remains tight.

‘Costly’ Loans

“These issues make mortgages more costly and unpredictable
for companies and far less consumer-friendly,” Dimon wrote.
“In many cases, deserving lower- and middle-income consumers
may pay far more than they might have in the past for a mortgage
or, worse yet, they won’t be able to get one.”

Fannie Mae and Freddie Mac provide liquidity to the
mortgage market by buying loans and packaging them into
securities. Lenders who sell loans to the two companies sign so-called representations and warranties guaranteeing that the
mortgages meet specific underwriting standards; if it turns out
that the loans didn’t meet those requirements and later default,
that agreement allows Fannie Mae and Freddie Mac to demand that
the lenders buy them back.

The problem, lenders say, is that they’re sometimes asked
to repurchase mortgages that were originated many years earlier
and it isn’t always clear what constitutes a serious
underwriting flaw.

‘Foot Faults’

“How do you separate foot faults from what would be
otherwise material or egregious mistakes in loan
documentation?” Stevens said. “For how many years should you
be accountable ultimately for a file or documentation error?”

As the housing market collapsed in 2008, Fannie Mae and
Freddie Mac were placed into U.S. conservatorship and required
$187.5 billion in taxpayer funds to stay afloat. Under the
direction of the FHFA, the companies combed through defaulted
loans that were originated during the bubble years, from 2005 to
2008, to make sure that banks paid when defaulted loans
shouldn’t have been originated in the first place.

The housing bubble was fed by millions of mortgages issued
by banks to people with subpar credit, and the buyback program
was designed to make sure all of the cost didn’t land on
taxpayers.

Both companies largely finished their reviews of those
legacy loans at the end of 2013. Now, after banks bought back
$37.8 billion of those old mortgages last year alone, Fannie Mae
and Freddie Mac’s heightened reviews of newly originated loans
are causing banks some concern.

‘Adding Insult’

“The legacy issue is largely gone, and they’re focusing
their resources now on all of the performing loans,” said Tim
Rood, chairman of Washington-based housing-policy consulting
firm Collingwood Group LLC. “It feels to lenders a little bit
like adding insult to injury.”

The steps Watt is announcing today are just a beginning of
the effort to ease lenders’ concerns. The FHFA is also
considering allowing banks to fix some curable defects such as
missing paperwork instead of automatically requiring buybacks
when such flaws are found. The agency may also set up an
independent arbitrator to weigh in when lenders and Fannie Mae
or Freddie Mac can’t agree whether a loan is defective enough to
require a repurchase.

“We know there is more to be done,” Watt said.

The agency started making changes to its buyback rules in
January 2013, when Watt’s predecessor, Edward J. DeMarco,
declared that lenders would no longer be liable for loans with
three years of on-time payments. The FHFA also began checking a
sample of mortgages soon after origination to flag potential
problems long before the loans went bad.

Quality Improved

Marianne Sullivan, a Fannie Mae senior vice president, said
the early checks have already helped lenders improve the quality
of loans they produce because the company provides training when
it uncovers a pattern of, for example, improperly computed
income or appraisals.

Newly originated loans in Fannie Mae’s book of business
tend to stand up to scrutiny compared to mortgages issued during
the bubble years. Only 0.25 percent of loans issued between 2009
and 2012 have been subject to a repurchase, compared to 3.7
percent of those originated between 2005 and 2008, according to
Fannie Mae data.

Credit has begun easing slightly, a trend that Fannie Mae
Chief Executive Officer Timothy J. Mayopoulos attributed to
rising interest rates that have sapped the refinancing boom as
much as to the efforts to improve certainty around loan
repurchases.

Rising Rates

Interest rates on 30-year fixed-rate mortgages rose from a
record low of 3.31 percent in November 2012 to 4.58 percent in
late August, according to Freddie Mac surveys. Rates fell last
week to 4.21 percent. Wells Fargo & Co., the biggest U.S. home
lender, in April cut its minimum credit score for borrowers of
Fannie Mae and Freddie Mac-backed loans to 620 from 660,
following similar moves from smaller banks.

“We are seeing that lenders are removing some of the
credit overlays that they had previously put on when loan
production was quite high,” Mayopoulos said.

That easing is only going to help on the margins, said
Laurie Goodman, director of the Housing Finance Policy Center at
the Urban Institute in Washington.

To broaden credit availability, it will be important for
the FHFA, Fannie Mae, and Freddie Mac to set out a clear
timetable for improving the buyback process, she said in an
interview.

“I don’t think you have the overlays removed until the
situation is clarified,” she said.

Two-Year Release

Studying loan performance data released by Fannie Mae and
Freddie Mac, Goodman concluded the companies could relax their
buyback requirements even further than they have without
incurring major losses. She recommended that the companies
relieve lenders of liability after only two years of on-time
borrower payments.

For now, lenders including Wells Fargo say they’re
encouraged by the steps FHFA is taking.

“The importance of certainty around how we manufacture
loans, and what constitutes a defect, is part and parcel to
bringing back the mortgage market that we all want to have,”
Wells Fargo Executive Vice President Peter Diliberti said in an
interview.